Bankruptcy Judge Jason D. Woodard of Aberdeen, Miss., tackled a problem that reads like a law school final exam question, because there is no direct answer in the statute or decisional law. He came up with an answer that gave money to a chapter 13 debtor and her creditors but not to the secured lender.
A husband and wife confirmed a chapter 13 plan where the secured lender on their mobile home was paid by the trustee. The lender was treated as a long-term creditor under Section 1322(b)(5), so it was not paid in full. However, the debtors made all required payments under the plan, curing a default on the mortgage and keeping the lender current during the life of the plan.
After the debtors received their discharges and the case was closed, the debtors defaulted on the mortgage. The lender foreclosed, sold the property, and ended up with an unsecured deficiency claim that, the parties agreed, was not dischargeable under Section 1328(a)(1).
Also after the case closed, the trustee reopened the case to administer settlement proceeds from the wife’s personal injury claim. If only unsecured creditors were paid, there would be a surplus for the wife because unsecured creditors would be paid in full. If the lender were to participate in the distribution pro rata, unsecured creditors would only receive about half of their claims, with nothing left for the wife.
The lender wanted to participate as an unsecured creditor on account of its deficiency, understanding that the remainder of its deficiency claim would be discharged.
Judge Woodard was tasked with deciding whether the lender was entitled to share in the proceeds. Observing there was a “dearth of law on the issue,” he concluded in his May 10 opinion that only unsecured creditors and the wife were entitled to the proceeds.
There was “no dispute,” Judge Woodard said, that the lender would not have been entitled to a distribution from the settlement proceeds while the case was pending and the mortgage was current. The lender, he said, did not have an unsecured deficiency claim until after discharge and the case was closed.
“It logically follows, then, that a post-discharge change in a creditor’s circumstances does not affect that creditor’s entitlement (or not) to participate in the distribution.” The lender, Judge Woodard continued, “received everything it was entitled to receive under the plan.”
Judge Woodard ended his opinion by highlighting the equities. The lender, he said, was free to collect the deficiency because that debt was not discharged. On the other hand, debts owing to unsecured creditors were discharged, making the proceeds “the only recovery those creditors will receive.”
Judge Woodard therefore directed the trustee to make the distribution to unsecured creditors, giving the wife any surplus.